Should I convert my 401(k) to a Roth IRA?

Remember that the biggest difference between a 401(k) and a Roth IRA is when the income is taxed. With a 401(k), taxes are deferred until after retirement. With a Roth IRA, you pay taxes now, but can take the money out tax-free when you are retired. For that reason, the decision to convert from a 401(k) to a Roth IRA depends your current income tax rate and the rate you expect to pay when you retire.

The rule of thumb is this: If you expect to be in a higher tax bracket when you retire, convert to a Roth IRA. Here's why. If you currently pay a 25 percent tax on your income, it's better to pay now and reserve your tax-free Roth IRA distributions for retirement, when you are in the 35 percent tax bracket.

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But why would anyone be in a higher tax bracket after they retire? Let's use Joe as an example. Joe makes a nice salary, but for most of his working years, he had the benefit of several large deductions and tax breaks that lowered his taxable income. Joe is married, has four kids, and owns his home, so he always filed jointly, took deductions for each dependent, and deductions for mortgage payments. He also maxed out his 401(k) contributions every year (the 2013 limit is $17,500), further lowering his taxable income.

By the time Joe retires, he won't be able to take any of those deductions, and he won't be making contributions to his 401(k). Even if he's taking in less income after retirement — from savings accounts, investments and Social Security — he may have more taxable income, putting him into a higher tax bracket [source: Updegrave]. That's when tax-free Roth IRA distributions pay off.

There are other advantages with a Roth IRA conversion. With a 401(k), you are required to start withdrawing from the account at age 70½. There's no such required minimum distributionwith a Roth IRA [source: IRS]. If Joe wants, he doesn't have to touch the money in his Roth IRA at all. Joe has always wanted to leave something behind for his kids and grandchildren. With a Roth IRA, Joe's heirs can also withdraw money from the account tax-free after he's gone [source: Spiegelman].

Now let's look at why Samantha, Joe's daughter, might want to stick with a 401(k).